道富銀行 (STT) 2003 Q3 法說會逐字稿

Good day, everyone, and welcome to the Investors Financial Services third-quarter earnings release conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Mr. Joe DeCristofaro (ph).

Please go ahead, sir.

Thank you for joining us on today's call.

We will be making a number of forward-looking statements, which are based on management's assumptions and predictions as of today.

The company's actual results may differ materially from our current predictions due to anyone of a number of factors.

Information regarding the factors that may affect our actual results is set forth in the MD&A section in our most recent 10-Q and 10-K filings with the SEC.

I recommend that anyone listening to this call review these reports carefully.

Because this call will be archived on our website, www.IBTCO.com, I want to emphasize again for anyone listening at a later date that the statements made today are based on our assumptions as of today, October 15, 2003.

These assumptions may change, but the recording of this call will not be updated.

Joining us on today's call are Kevin Sheehan, Chairman Chief Executive Officer;

Mike Rogers, President; and John Spinney, Chief Financial Officer.

I will now turn the call over to Kevin Sheehan.

Thanks.

I will begin by reviewing some of the key points from our third quarter, and then John Spinney will discuss our financial results in more detail.

Investors Financial Services recorded extremely impressive results for the third quarter of 2003.

Diluted operating EPS for the quarter came in at 40 cents, up 25 percent on a linked-quarter basis; up 14 cents or 54 percent from quarter three of last year.

As of September 30, we processed approximately 956 billion of assets for our clients, up 59 billion from June 30, 2003.

For a little more detail on the assets processed, we converted approximately 25 billion of assets from numerous existing clients during the quarter, including Aegon, BGI Canada, BGI USA, Eaton Vance, Goldman Sachs, PIMCO, and Vega.

We also converted about $1 billion from new clients such as EMC, Lehman Brothers, and some institutional custody clients.

We (technical difficulty) appreciation and client fund flows of 33 billion during the quarter.

The strong rise in assets processed that we have witnessed this year has resulted from both our ability to sell new business, 35 billion during the first 9 months of 2003, and the rise in equity values over the past 6 months.

The current status of our new business pipeline remains medium.

We believe that the positive capital market environment during the second and third quarters has created some momentum on several new business opportunities.

We feel that this shift in market sentiment may lead to shorter decision cycles and create opportunities to close new business during the final quarter of 2003 and into 2004.

To summarize, again, we delivered excellent results for our investors during the third quarter of 2003.

These results were driven by our ability to sell new and existing clients, our continued focus on prudent expense management, and solid equity market performance.

I will now turn the call over to John Spinney, who will review the quarter's financial results in more detail.

Good morning.

As Kevin mentioned, third-quarter diluted operating EPS came in at 40 cents a share, up 8 cents or 25 percent on a linked-quarter basis.

Our diluted EPS of 40 cents represents a 54 percent increase over our third-quarter 2002 diluted EPS of 26 cents.

On year-over-year basis our net operating revenue increased 9 percent, compared to a 5 percent decrease in operating expenses, exhibiting the earnings growth potential and inherent leverage in our model.

On a linked-quarter basis, revenue decreased 2 percent, versus a 10 percent decrease in our cost structure.

Each of our revenue sources represents a component of our compensation for providing asset processing services to our clients.

Net interest income is one of these components and results from investing the residual cash of our asset processing clients, who use our balance sheet as a convenient way to invest their excess cash.

We generate asset servicing fees based on assets under administration, the number of transactions generated by our clients, and managed risk (ph) income.

These three revenue components create a natural hedge for our business model, which has been one of the factors enabling us to succeed in a variety of market environments.

The breakdown of our revenue stream for the third quarter of 2003 was 55 percent asset based, 15 percent transaction based, and 30 percent net interest income based, continuing the shift that we have witnessed recently to more of a contribution from asset-based fess as opposed to net interest income.

I will now discuss the significant income and expense components in more detail.

Cora asset servicing fees increased 13 percent year-over-year and 5 percent linked quarter, due to favorable market conditions, the addition of new clients such as BGI Canada, and the ability of our clients to continue to develop and sell new products.

Transaction-driven income, in which we include our ancillary services such as securities lending, foreign exchange fees, and cash management fees, increased 12 percent year-over-year, driven by strong increases in FX and cash management fees.

On a linked-quarter basis, transaction income decreased 10 percent, primarily as a result of linked-quarter decrease in our FX and securities lending businesses.

Regarding FX, despite beating our expectations for the quarter and being up 19 percent on a year-over-year basis, lower volatility and volumes in the currencies traded by our clients during the third quarter compared to the second quarter caused a linked-quarter decline in FX revenue.

Securities lending decreased 12 percent year-over-year, due to a smaller lending book, and declined linked quarter primarily due to the end of the international dividend season.

Net interest income was flat on a year-over-year basis and decreased 8 percent linked quarter, primarily due to increased prepayments in our mortgage-backed securities portfolio through most of the summer.

We expect lower prepayment activity in the fourth quarter.

Also we recorded an additional interest expense in the third quarter of approximately 1 million related to the ineffectiveness of our swap portfolio in accordance with FAS 133.

The 1 million will flow back into net interest income over the remaining life of the swaps.

Absent a further cut in the Fed funds rate, we expect little to no impact going forward.

We continue to maintain strong net interest margin spread as a result of continued healthy levels of client funding.

The linked-quarter net interest margin decreased by 27 basis points to 1.81 percent, while the linked-quarter interest rate spread contracted by 26 basis points to 1.71 percent.

Compared to the same quarter of last year, net interest income was flat, primarily as a result of a larger balance sheet offsetting a lower interest rate environment.

Approximately 98 percent of our investment portfolio is invested in securities backed by the U.S. government and/or Triple-A rated securities.

We continue to run a closely matched balance sheet, with an asset duration of approximately 1.5 years and a liability duration of approximately a year.

The high amount of variable-rate securities in our portfolio has allowed us to maintain a low asset duration.

Total operating expenses were down 10 percent linked quarter compared to our 2 percent decrease in revenue.

Comp and benefits expense declined by 16 percent on a linked-quarter basis, mainly due to lower bonus accruals and lower headcount.

Contributing to this decline in compensation expense has been our ability to harvest operational efficiencies through our implementation of technology solutions.

Technology and telecommunications expense was up 6 percent linked quarter, due to increased spending on projects to meet client needs, increase our internal efficiency, and reduce risk.

Transaction processing was down 23 percent linked quarter, due to lower subcustodian fees resulting from lower transaction volumes.

Depreciation and amortization increased 14 percent linked quarter, as projects that were previously capitalized were placed into service during the third quarter of 2003.

Professional fees were down 28 percent on a linked-quarter basis, as a result of the end of costs related to the resettlement, the dismissal of the Mopex case, and the resolution in July of the California overtime lawsuit.

We will continue to maintain strict cost controls, while we increase our cost structure to support the addition of new business.

During the third quarter we announced that we reached an agreement in principle with representatives of the plaintiffs to settle a class-action lawsuit alleging violations of California wage and hour laws in our Sacramento and Walnut Creek facilities.

In anticipation of this settlement and related costs, the company accrued a liability of approximately 1 million in the second quarter of 2003.

We continue to be cautiously optimistic about the capital markets and interest rate environment.

As such we are increasing our GAAP EPS guidance to a range of $1.30 to $1.32 a share for the year ended December 31, 2003; and we're revising our diluted operating earnings-per-share target to a range of $1.41 to $1.43.

We remain comfortable with our long-term growth rate of 25 percent in EPS.

I would now like to open up the call to your questions.

The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) Jon Arfstrom, RBC Capital Markets.

A question for you on the 25 billion that you talked about, Kevin.

What is that?

Is that clients giving you more money?

Or is it new products?

Or what is behind that?

It is new product offerings and growth in existing products.

So that is just further penetration of the client base?

Yes.

And how much of the Barclays Canada business is in the 25 billion or in the 59 billion that you added for the quarter?

Is that any at all?

Yes, 22 billion, Jon.

Expense control, I am sure that you maybe had questions about this already.

But is that level of expenses that you have sustainable?

Or do we expect that to go up in the fourth quarter?

I think it is sustainable for the fourth quarter.

Any change in the structure of the balance sheet?

It looks like you added 400 million in deposits and a little less in terms of investment securities.

Would you expect it to grow little bit if prepayment is slow in the next quarter?

No, I think it may grow a little bit, but I think we're targeting somewhere around 8.5 to 8.8 billion for the end of the year; total balance sheet average about 8, 8.1, something like that.

And then in terms of your guidance, any change in the typical assumptions that you give for a flattish market?

In terms of rate environment?

Rate environment and equity market levels.

We have no equity market upside built into our estimates.

We never do that.

In terms of interest rate environment, in terms of the rest of the year, obviously we don't think debt funds is going anywhere from where it is today.

And the ten-year will probably trade somewhere, we hope, within the 4 percent range.

Okay.

And you're still comfortable with the 25 percent growth rate on that $1.40 to $1.43?

Currently we are.

Yes, Jon.

Thank you.

Brad Moore of Putnam Lovell NBF.

A couple of things.

I wanted to understand the interplay between the -- you characterize the pipeline as medium; and yet it sounded like you were relatively bullish with regard to the momentum you are seeing on the new business front.

I just wondered if you could square that up for me.

I think there is a couple of opportunities in there that we have talked about in the past, Brad, that are getting closer to fruition.

And I think just in general there's more opportunities coming across our desk.

We're responding to more RFPs.

I think the general sentiment has been an uptick, and that is why we feel a little bit more positive and bullish on the sales front.

So the difference then would be it is a difference between having an increase in the number of conversations and the number of bids, versus actually having something in front of you that you can sign?

I think it is a little bit of both.

We continue to sign, as Kevin mentioned in his remarks.

There is a handful of clients that launched new products in the third quarter.

And we're seeing a lot of that going on right now.

So we are actually signing things from existing clients.

We have got some good opportunities in the pipeline in front of us that have a potential to close late this year, early next year.

We continue to get RFP activity, and our clients continue to create ideas and products that we're bidding on as well.

And then with regard to the 25 billion that you signed up from existing customers.

Was there any pricing changes or concessions given in terms of -- that includes renewals, I assume.

So were there any concessions or changes in pricing from your typical rates?

First I will answer the second question.

We never include renewals as a new sale, so there are no renewals in the numbers.

And then secondly, the pricing front, all this pricing is at what we currently expect to achieve from a margin perspective.

And there were no givebacks or reductions in pricing.

Okay and then finally just curious, any significant client con coming up for renewal in the next couple of quarters that you are aware of?

Nothing major.

Anything that was coming up of significant we have pretty much signed up.

We've got about 65 percent of our assets on long-term contract till the end of '05 right now.

Great, thank you.

(technical difficulty) Tom McCrohan with KBW Asset Management.

A quick question on the expense reductions.

I was not expecting to see the expenses drop like that.

I thought it was a pleasant surprise to see that.

But can you give me some flavor for the staff reductions, and if they were like targeted reductions in certain areas?

Or did you consolidate some type of group into one group?

How did you go about doing that?

I think, Tom, what we're talking about is putting into place technologies that have (technical difficulty) to reduce our headcount throughout the year.

And a good part of that in the third quarter.

And that is really what we were talking about.

There were no layoffs or any planned staffing reductions or anything of that nature.

We continue to add new business, so we can't be laying people off.

So the reduction in expenses was not related to people leaving, but being replaced by technology?

For the most part, yes.

Do you feel comfortable that that is a run rate for the fourth quarter?

Yes, I do.

One last question.

You had broken up the revenue into 55 percent asset-based, 15 percent transaction based, 30 percent net interest income.

What do you consider the asset base of your income items?

It would be our core fees, which is custody fund accounting, which are AUM-based fees.

In fund administration, excuse me.

And FX, cash management, sec lending?

That would be all (multiple speakers) transaction?

Yes.

Okay, thanks very much.

(OPERATOR INSTRUCTIONS) Casey Ambrich (ph) with Millennium Partners.

One concern that some investors have had is regarding the potential NBS mark that the company might incur with the ten-year moving up here; the yields anyway.

I was wondering if you could talk a little bit about your swaps on the liability side of the balance sheet?

And how that works to hedge that?

Certainly from the ten-year perspective on the asset side of the balance sheet, the mark on that is positive still.

It has never run into a negative mark to market.

And we're very comfortable with that, and it doesn't have an impact on our regulatory capital if it did.

Secondly on the swap portfolio, we use swaps basically against some of our deposit liability products to extend the maturities and fix those against fixed-rate assets.

That really helps us to keep the duration up on the liabilities and matched with the asset duration.

Great, thank you.

Kyle Cerminara with T. Rowe Price.

Great quarter.

Quick question.

What percent of your current customer assets have you penetrated?

We've got about 7.2 percent of our client assets (technical difficulty) what we serve.

Now going forward, would you see more opportunity within the current customer base or within new business?

Because it seems like if you only have penetrated 7.2 percent of your current customer base, there is a lot of opportunity within.

I think the opportunity is immense.

It is 20-something trillion of assets or 17 trillion, I can never remember the number off the top of my head.

But clearly when you have a client, it is always easier selling into an existing client.

We do sell a ton of business to existing clients every year.

We don't necessarily report it on every single call.

And we expect that continue in the future and drive that number up.

Clearly as we have said in the past on calls and when we meet with investors, we go at it from both fronts all the time.

From the sales front, we've got dedicated sales force out there.

Got based on territories, going after opportunities that we don't currently have and generating our fee activity and new clients.

Then there are the client managers, who are charged with client service delivery, are charged with making sure service is what is expected; but more importantly from a financial perspective, cross-selling services and helping our clients develop product that obviously drives revenue to our firm.

Great.

And of the current potential customers, new customers that are in your pipeline, could you expand upon it?

Are they large asset managers?

Are they medium-sized asset managers?

Or whatever color you can give us would be helpful.

They are from some of the largest in the world to some of the smallest.

It goes -- again, it is quite a few.

Great quarter and thanks for taking my call.

(OPERATOR INSTRUCTIONS) Zachary Cohen (ph) with Eagle Capital Partners.

This is actually Meryl Witmer.

Excuse me for being a little dense, but I am just looking at the comp and benefit line, which I believe went from almost 51 million in the second quarter to 42.5 million this quarter.

Is that like a lower bonus accrual?

If you didn't let anybody go, is that a lower bonus accrual?

Did people leave?

Did you have some consultants you are now paying?

What caused that?

Some of that is bonus accrual; and some of that is taking the efficiencies in terms of headcount reductions in the business.

So there were headcount reductions?

As a result of not replacing positions for people that left the firm, where we had efficiencies in the technology that allowed us not to replace positions.

I see; so you let some people run off and the technology took its place.

Exactly.

It just goes hand-in-hand with depreciation expense being up because we put the technology in place.

I see.

That ties in nicely.

Now the lower bonus accruals, is that a foreshadowing of things not great to come?

I think part of that, and we talked about it on the second-quarter call, was just a tremendous second quarter for us.

Having the ability to accrue bonuses against hiring earnings in the second quarter; that allowed us to take lower bonus accruals going forward.

And I think giving the REIT charge we took, we're not going to reach the potential of maximizing bonuses.

So our accruals are going to be lower just as a result of that.

So did you front-end load the bonuses into the second quarter?

We accrue bonuses when we have the room (ph) in the EPS that marries up to it.

So if the performance is there, we will accrue bonuses up against the performance.

Although this quarter is very good also.

It is.

But as we went into the third quarter, we looked at last year and said, last year's third quarter was not the best quarter in terms of transactional revenue; and the markets really took a sharp downturn; so we were not about to get behind the eight-ball on bonus accruals, and have to make up for it in the summertime.

Okay, thank you.

Joel Gomberg with William Blair.

John, I missed your comments on guidance.

Your previous operating diluted EPS guidance was $1.30 for this year.

What is it now?

GAAP is $1.30 to $1.32; operating is $1.41 to $1.43.

And the other question I had; how should we look at asset values and how you bill for them?

Is it daily?

Is it average for the month, and then you bill monthly?

How exactly do you bill the asset fees?

Most of it is average daily net asset value.

With some that bills at end of period on the months; there's some that bill at end of quarter.

But if you're looking for something to track well, I'd probably use an average net asset value over the period.

And the mix of your custody is a mix between equities, fixed income, and cash.

Can you give me a rough ballpark?

70/30. 70 equity; 30 fixed income.

Thank you.

A follow-up from Casey Ambrich.

One last quick question.

Can you give some color on how the margin changed by month?

I will start with that.

The net interest margin?

By month I don't think it's really that important to go through in detail.

But if you look at the decline sequentially, the biggest contributor to that was obviously the prepayments on the mortgage-backed portfolio, that caused earnings to go down on the net interest income line.

I actually added back the effect of that prepayment; and it probably gets us back to somewhere like 195, 196 from a margin perspective.

So I clearly isolated the prepayments on the mortgage-backed portfolio.

But we have those slow down now, and we are anticipating to have a fourth quarter of very slow prepayments relative to the third quarter.

So we should expect around a 190 for fourth quarter?

I wouldn't go that high.

But I just added back what happened in the third quarter.

Okay, thanks very much.

A follow-up from Jon Arfstrom.

Anything seasonal that is going to impact value-added, that you can see in the fourth quarter?

I know you talked about the end on (ph) tax season, but anything in the fourth quarter?

No, not really.

Thanks.

A follow-up from Tom McCrohan.

Quick follow-up on the duration of your assets.

Did I hear you say it was 1.5 years?

Yes.

What drove that?

I thought in the past it was closer to 2.5 or 2.2 or something like that.

It has always been 1.2.

It was 1.2 when I met with you down in New York; and it is about 1.5 now.

It has never been 2.2.

Never, okay.

Thanks.

And this concludes the question-and-answer session.

A replay of this call will be available starting at 12:00 noon Eastern time today and will run through October 21 at midnight Central time.

To access this replay please dial 719-457-0820 and enter in the pass code of 531873. (OPERATOR INSTRUCTIONS) This concludes today's conference call.

Thank you for your participation.